WELCOME

An
Assignment on
Determination of Optimal Levels of
Production and Factor Application
Course no.-Ag. Econ.504

Submitted to Submitted by
Soumya C. Patel Parul M.
M.Sc. Agril. Econ.(2nd Sem.)
Assistant professor,
Reg.No.- 04-AGRMA-
Dept. of Agril. Econ.
01804-2018
C.P.C.A., S.D.A.U.
Factor - Product Relationship

Is also known as Classical production

relationship.
It examines relationship between one
variable factor and output, keeping the
quantities of other factors fixed.
It is a short run production function.
It explains the Law of Variable
Proportion or the Law of Diminishing
Marginal Return.
The Law of Variable Proportion/ Law
of Diminishing Marginal return
 The proportion of one factor in a combination of factors
increased, after a point, first the marginal and then the
average product of that factor will diminish.
 Therefore, its known as Law of Diminishing Return.
 The Production function:

Y = f (X1 / X2 ,X3,…, Xn)

 Objective
 To find out optimum level of resource use or resource
optimization.
 The management problem associated with this analysis is
“How much to produce?”
 Example
Input Output Marginal Marginal AP MP Remarks
(X) (TP) input Output (Y/X) (∆Y/∆X)
(X) (∆X) (∆Y)
0 0 - - - - Increasing at
increasing rate
1 2 1 2 2.00 2
2 5 1 3 2.50 3
3 9 1 4 3.00 4
4 14 1 5 3.50 5 Increasing at
constant rate
5 19 1 5 3.80 5
6 23 1 4 3.83 4 Increasing at
decreasing rate
7 26 1 3 3.71 3
8 28 1 2 3.50 2
9 29 1 1 3.22 1
10 29 1 0 2.90 0
11 28 1 -1 2.54 -1 Decreasing
(negative return)
12 26 1 -2 2.16 -2
Three Stages of Production
Zone –I :Stage of Increasing Returns
 Starting point - Origin
 Ending point - MP = AP(max)
 TP increases at increasing rate upto the point of
inflection.
 MP is also increases upto the point of inflection.
 AP is increasing throughout this stage.
 MP>AP
 EP > 1 (Throughout this stage)
 EP = 1 (At the end of this stage)
 This is irrational zone because, the AP increases
throughout this zone indicating that the efficiency of all
the variable inputs keeps on increasing.
Zone–II: Stage of Decreasing Returns
Starting point = AP max
Ending point = MP = 0
TP increases at decreasing rate.
MP < AP, but both exhibit declining trend.
EP < 1 (Throughout this stage)
EP = 0 (At the end of this stage)
This is rational zone.
Zone –III: Stage of Negative Returns
Starting point = MP = 0 or TP= Max.
TP decreases at increasing rate.
AP decreases throughout this stage.
MP becomes – ve.
EP < 0.
This is a irrational zone because in this
zone the TP is decreasing and MP becomes
negative which indicates that additional
quantities of inputs reduces the total output.
Summary Of Three Zones
Zone –I Zone –II Zone –III

From origin to AP=MP From AP=MP to MP=0 From MP = 0 to onwards

TP, AP & MP all are TP is increasing but at a TP, AP and MP all are
increasing decreasing rate. MP & decreasing. MP becomes
AP decreasing but are negative.
positive.

EP > 1 EP < 1 EP < 0

Stage of increasing Stages of decreasing Stages of negative return

return return
Irrational zone Rational zone Irrational zone

Zone of underutilization Zone of optimum level Zone of overutilization

of resources of resources of resources
Optimum level of input use
Optimum level of input use will be at the
stage where the cost of additional input(MC)
and the value of additional product(MR) are
equal. i.e., MC=MR. to calculate optimum
level, data regarding price of input as well as
output will be required.
Suppose, price of input is Rs.5/ unit and
price of output is Rs.4/unit.
In this example, the optimum use of resource
is somewhere between 8 & 9 unit.
Input Output Total Total Marginal Marginal Net
(X) (TP) cost return cost return return
(X)

0 0 0 0 - - 0
1 2 5 8 5 8 3
2 5 10 20 5 12 10
3 9 15 36 5 16 21
4 14 20 56 5 20 36
5 19 25 76 5 20 51
6 23 30 92 5 16 62
7 26 35 104 5 12 69
8 28 40 112 5 8 72
9 29 45 116 5 4 71
10 29 50 116 5 0 66
11 28 55 112 5 -4 57
12 26 60 104 5 -8 44
Factor- Factor Relationship
Any production activity requires different
inputs to produce a given quantity of
output. There are many ways of
combining these resources in production
process.
The factor- factor relationship is
explained by the law of factor
substitution.
In this relationship, two factors or inputs
are varied and the output is kept constant.
Production function
Y= f (X1, X2/ X3 , ……, Xn)

Where, Y = A fixed level of output

X1,X2 = Variable inputs
X3,X4,….,Xn = Inputs which remains constant

 Objective
 To find out the most appropriate combination of inputs that
costs the least amount in producing a given level of output or
cost minimization.
 The management decision associated with this analysis is
how to produce? i.e., which combination of two factors to be
used?
Iso-quant
Iso means equal and quant means
quantity.
The curve representing all combination of
X1 and X2 that produce the equal quantity
of output is called an iso-quant.
It is also termed as iso-product or product
indifference curve.
If a number of iso-quants are drawn in
one graph, it is known as iso-quant map.
Iso - Quant Curve Iso- Quant Map
Characteristics/ properties of iso-quant
Iso- quant is downward slopping from
left to right. i.e., negatively sloped.
Iso- quant is convex to the origin.
Iso-quant placed above represent higher
output and vice-versa.
Iso-quants are non- intersecting.
 Marginal rate of technical substitution
(MRTS)
 It is the rate of exchange between two inputs which are
equally preferred.
 It indicates the absolute amount by which one input is
decreased or replaced to add a unit of another input.
 Alternatively, the quantity of one input to be sacrificed
or given up in order to gain another input by one unit, in
process of substitution.
MRTS = Quantity of replaced inputs
Quantity of added inputs
 MRTS of X1 for X2: MRTSX1X2= ∆X2/∆X1
 MRTS of X2 for X1: MRTSX2X1= ∆X1/ ∆X2
Iso-cost line
Iso-cost line represents various combination
of two inputs that can be purchased with the
given amount of money.
It is known as price line or budget line.
It can be drawn by locating the end points of
X1 and X2 that can be purchased from the
given amount of money.
It plays an important role in determining the
combination of factors that the farmer should
choose for production.
Characteristics of Iso-cost Line
 Iso-cost line is always a straight line.
 The slope of iso-cost line shows the
inverse price ratio of inputs.
 Change in input prices will change the
slope of the iso-cost line.
 When the total outlay or budget is
increased, the iso-cost line shifts
upwards to the right and it moves
farther away from the origin and vice-
versa.
 Iso-cost lines are parallel to one other,
since relative price ratio remains
constant.
 Least cost combination
Factor- factor analysis is mainly concerned with
the determination of least cost combination of
resources.
There will be many combinations of two resources
that produce the same level of output.
The problem here is to find out particular
combination of inputs, which produce a given
quantity of output with minimum cost.
There are three methods of finding out least cost
combination viz., Tabular Method, Algebraic
Method and Graphic Method.
 Example
 A farmer wants to produce 1000 kg of paddy per acre land. He
has two types of fertilizers viz., Manures and Urea that can be
used to produce the crop. The following combinations of
Manures and Urea produce the same quantity of output. i.e.,
1000 kg of paddy per acre. Price of manure is Rs. 200/cart-load
and price of urea is Rs. 5/kg.
Combination Manure (X1) Urea (X2)
(qty. in cart-load/acre) (qty. in kg/acre)
A 1 200
B 2 125
C 3 80
D 4 50
E 5 30
F 6 17
G 7 10
1.Tabular method
Combination Manure Urea Cost of X1 Cost of X2 Total cost
(X1) (X2) (X1*PX1) (X2*PX2)
(qty. in cart- (qty. in
load/ acre) kg/acre)
A 1 200 200 1000 1200
B 2 125 400 625 1025
C 3 80 600 400 1000
D 4 50 800 250 1050
E 5 30 1000 150 1150
F 6 17 1200 85 1285
G 7 10 1400 50 1450

Conclusion : Total cost of “C” combination is the minimum (least) among

all. Therefore, the farmer should use 3 cart-load of manure and 80 kg of Urea
to produce the given output
2.Algebraic method
Step-1 : Compute the marginal rate of
technical substitution (MRTS)
MRTS X1X2 = ∆X2
∆X1
Step-2 : Compute the price ratio (inverse)

PRX2X1 = PX1
PX2
Step-3 : Find out the least cost combination

by equating MRTS with inverse PR

Calculation of MRTS and Price Ratio
Combi- Manure Urea ∆X1 ∆X2 MRTS PRX2X1
nation (X1) (X2) X1X2= = PX1
(qty. in (qty. in ∆X2 PX2
cart- kg/acre)
load/
acre) ∆X1

A 1 200 - - - -
B 2 125 1 75 75 40
C 3 80 1 45 45 40
D 4 50 1 30 30 40
E 5 30 1 20 20 40
F 6 17 1 13 13 40
G 7 10 1 7 7 40
Combinati Manure Urea ∆X1 ∆X2 MRTS PRX1X2
on (X1) (X2) X2X1 = PX2
(qty. in (qty. in = ∆X1 PX1
cart-load/ kg/acre) ∆X2
acre)
A 1 200 - - - -
B 2 125 1 75 0.013 0.025
C 3 80 1 45 0.022 0.025
D 4 50 1 30 0.033 0.025
E 5 30 1 20 0.050 0.025
F 6 17 1 13 0.077 0.025
G 7 10 1 7 0.143 0.025

Conclusion : At combination “C” MRTS =PR is observed. So, this

combination is the least cost combination. Therefore, the farmer should use
3 cart-load of manure and 80 kg of urea to produce the given output.
3.Graphical method
Step-1 : draw iso-quant on a graph paper.
Step -2: draw Iso-cost line on the same graph
paper.
Step-3 : if required, move the iso-cost line or
draw the parallel line in such a way that it
intersects the iso-quant at one point. This
point indicates the least cost combination of
two inputs.
THANK
YOU